The Wyre Catchment Natural Flood Management Project is the first example in the UK of the use of repayable private investment enabling the delivery of natural flood management. The project will deliver more than 1,000 targeted measures to store, slow and intercept flood water and prevent peak flow in a catchment in England, with the interventions hosted by local farmers. Beneficiaries of the reduced flood risk are paying for the interventions through an extendable nine year ecosystem services contract, and the Project’s Community Interest Company has successfully raised a nine-year £850k private loan facility to help fund the up-front capital cost of the interventions.
With many thanks for their time and insight on this case study:
Dan Turner, Technical Lead, Land Management and Market Creation, The Rivers Trust
Dan Hird, Principle and Founder, Nature Finance
Date published: 08/12/2022
Defining the investment ask
The project team determined that it would need up-front external repayable investment early in on the project’s development – and in fact this was one of the ambitions and proof points which the project was intended to deliver. The buyer group was flexible between making capital contributions and revenue payments and in fact many large organisations (the Environment Agency, water companies, etc.) find it easier to pay for capital than revenue items. However, the buyer group was willing to cover the lifetime costs of the project through a nine year contract enabling the team to test appetite for raising repayable private up-front investment. The buyer group recognized some benefits through this approach in that they would effectively be paying for the interventions over time and as they proved effective. The £1.5m project was able to access government grants to plant the hedges and the woodlands (via the Woodland Trust), but this only covered around 40% of all the implementation costs, and did not cover other elements, such as maintenance and monitoring.
After developing the project delivery plan and a detailed financial model, the project team identified a requirement for an £850,000 up-front investment to be drawn down in stages over the first three years of the project, in addition to the £550,000 of tree planting and hedgerow creation grants offered by Woodland Trust. This combination of private repayable investment (£850,000) and environmental grants (£550,000) is a good demonstration of “blended finance” for a £1.5m project.
The private investment was structured as a nine year loan facility – with drawdown taking place over the first three years to coincide with delivery of the NFM interventions in the catchment – and the repayment between Years Four to Nine. The nine-year loan agreement was carefully designed to tie in with the nine-year ecosystem service contracts with the buyers and the nine-year agreements with the land managers. The financing structure designed by Triodos as adviser to the project is therefore more like debt based project finance (similar to that used in infrastructure projects such as renewable energy installations) than an equity type investment in a start-up business. The use of a CIC limited by guarantee enables the use of debt instruments but not issuing of equity, because the CIC does not have shares.
In terms of debt pricing, the financial model indicated that a 6% return would be feasible. However, the principal driver around pricing of debt is actual and perceived risk profile for investors. The Triodos Bank team had plenty of experience in raising capital for early stage social enterprise businesses and a good knowledge of risk to return appetite from impact investors. However, the Wyre CIC project is a brand new business model and so presentation of risk and proposal around interest rate on the loans was always going to be a discussion point with potential investors.
The Wyre Catchment CIC business plan prepared by Triodos contained a section detailing all of the major risk factors in the project, together with mitigating factors. Transparency around potential risks is vital when raising investment as it generates trust and confidence in investor discussions.
Ultimately, Triodos concluded that the commercial risk profile of this project relative to other unlisted bonds that it had raised on its investment crowdfunding platform. However, Triodos recognised that there was an opportunity to bring this down to a proposed 6% through the following approach:
- Focus on impact led investors who might value a “blended return” i.e. combination of financial, social and environmental return, rather than straight commercial investors.
- Structure the investment as two layers – an “institutional layer” and a “high net worth layer”.
- The institutional layer would have repayment priority over the high net worth investor in the event of a winding up. However, the high net worth layer could benefit from a tax relief on investment which compensates them for being in the highest risk position in the investment structure.
To move this forward, the project team worked hard to bring out the ‘blended return’ elements of the project to potential investors in that there were financial, social and environmental returns to the project. Dan Hird, Head of Corporate Finance at Triodos Bank and a core member of the project team, also started to explore the use of Social Investment Tax Relief (SITR) as an additional incentive to any private investors. This was ultimately successful but did take seven months of negotiations with HMRC (see below).
Identification and selection of investors
The project started to engage with impact investors in Spring 2021 around a year from when project development started, when the team were confident in having a robust business case and outline business plan and financial model.
At the very outset, and for completeness (and learning) several investor types were considered for the project. Hird spoke to large institutional investors Pollination, Mirova and Federated Hermes, which all had stated goals of channelling investments into nature restoration. While they found the project was innovative and in line with their sustainability strategy, the ‘ticket size’ of the investment was too small for their scope.
At the other end of the spectrum, the Triodos and the project team considered the potential for retail investment through crowdfunding, as Triodos Bank itself has a crowdfunding platform for sustainability-focused investments. However, crowdfunding finance is highly regulated in the UK to help protect retail investors with less capacity for due diligence, and the project team decided that the project was too complex to efficiently or fairly represent the risk profile to a large number of retail investors.
Instead, the project team decided to approach UK-focused impact investors and High Net Worth (HNW) individuals, who would have an appropriate target ticket size.
Triodos Bank has experience working directly with impact funds – such as family trusts and charitable foundations – that have been increasingly targeting projects with environmental outcomes as well as social outcomes over the last ten years. The project team consulted with the Esmée Fairbairn Foundation, who had supported the project’s development through grant funding. After an initial discussion and a review of the business case, the Esmée Fairbairn Foundation agreed that this was in line with the investment appetite of their Esmee Fairbairn Social Investment Fund, and Triodos were also able to bring in four other impact investment funds that had a similar scope for investment. Hird comments that many impact investment funds are very good at working collaboratively and sharing not only their findings during the due diligence process (see below) but also the actual investment requirement between them.
Triodos Bank also helped to draw together a list of HNW individuals who were the bank’s customers that had previously expressed an interest in making environmentally-focused investments. Due to the unique nature of the project, the project team decided to only approach three or four HNW investors that were capable of assessing the risk profile of the project and undertaking their own due diligence process. The existence of Social Investment Tax Relief was seen as a key driver to encourage these investors into the project.
Once the outline investment structure had been established, Triodos set about identifying and approaching both a) potential impact investment funds and b) potential HNW investors to test appetite for the project.
Initially, the project team prepared a two page ‘teaser’ summary of the project that included the:
- Indicative investment requirement
- Proposed investment terms
- Social and environmental impact
Triodos then used this to support an initial approach to a shortlist of impact investment funds.
To date, most impact investment funds have focused on the more mature social investment market rather than the nascent environmental or nature-based investment market. Since 2011, impact investment funds have tended to come together and share knowledge through the Social Impact Investment Group (SIIG) – an informal collaboration which meets quarterly. Triodos had many years of experience of dealing with the SIIG and was a regular presenter of investment opportunities to this group. Triodos was therefore able to approach a number of the SIIG members to test reaction and appetite for an investment in the Wyre Catchment CIC.
The first discussions were held with Esmee Fairbairn Foundation (EFF), which operates one of the largest and most long standing social investment funds in the UK – and that is (along with EA and Defra) co-development funders of the Wyre CIC project through the grants side of their business. Once indicative interest had been secured from EFF, Triodos expanded discussions to a handful of other experienced impact investors. It quickly became clear that there was strong interest in the investment from a group of five funds, and they jointly agreed that EFF’s social investment should take the lead on their behalf for the purposes of negotiating a term sheet and undertaking due diligence.
All of the initial investor discussions were done through Zoom/Teams, due to the Covid-19 pandemic) and were undertaken by Triodos. This was because Triodos knew all the investors, having worked with them for many years. Other members of the project team, particularly Dan Turner at Rivers Trust and Tom Myerscough at Wyre Rivers Trust, joined later calls as the investor due diligence process developed.
On this project, all of the investors who Triodos approached expressed an interest in an investment and it was straightforward to agree allocations of the £650,000 impact investment total between 5 organisations – with EFF being the largest investor at £250k. The project team did not have any investors who were not interested and is probably a result of Triodos having a good understanding of what impact investors are looking for and so being able to structure the project investment structure accordingly.
As the project developed into the second half of 2021, the project team were able to provide a full business plan, financial model and access to a virtual data-room to EFF and any other interested investors. Triodos negotiated an investment term sheet with EFF and this was signed around the end of 2021 – three months before the project completed. EFF introduced some ideas of their own including an biodiversity impact adjusted interest rate whereby the 6% headline rate would reduce to 5% if the project could demonstrate an agreed biodiversity gain through wetland and grassland creation using the Defra v3.0 metric (see below).
Alongside the impact investment fund discussions, Triodos ran a parallel discussion with a number of HNW investors known to the bank. A similar two page summary of the project was prepared, although this was slightly more geared towards an individual investor and also contained details of the proposed Social Investment Tax Relief (SITR) that was a key part of the investment proposition (see below). Triodos spoke to around six HNW investors and quickly managed to establish interest from four of these – each of whom agreed to invest £50k each if SITR could be offered.
Ongoing negotiations and due diligence
Once the shortlisted group of investors had expressed indicative interest they were given help to undertake due diligence which included meetings with the project team, regular Q&A with Triodos around the financial model and a draft term sheet. In practice, EFF led most of the due diligence process on behalf of the impact investor group. The individual HNW investors relied mainly on the business plan and the involvement of Triodos Bank as a trusted financial intermediary.
The entire due diligence process took around three months but was running in parallel with many other project workstreams, including buyer and landowner contract negotiations.
The project team also gave these investors access to the “virtual data room’, which was set up as a private SharePoint site. This contained all major documents such as the project’s business plan, the financial model, the hydrological model with written reports from the data workstream, the delivery plan for the interventions, all MoUs and draft contracts with the landowners, buyers and other partners in the project, and the incorporation documents for the Community Interest Company (CIC) that was set up to legally host the project’s operations.
Over the course of three months, these investors analysed these documents to determine whether the project was a credible investment, for example that it was profitable, well-managed and going to deliver robust environmental outcomes. Questions that these investors came back with included:
- To what extent has the delivery plan been confirmed?
- What is the risk of overspend in the first three years?
- How do the performance metrics serve as a proxy for a reduction in flood risk?
- Do you have a conflict resolution strategy for the CIC’s Board?
Most of these questions were first posed by the Esmee Fairbairn Social Investment Fund and the other impact funds. As the team went through these separate due diligence processes, it decided to include an ‘Investor FAQ’ document that would note down the ongoing questions from investors and its responses, available within the data room to share with the wider investor group.
Turner comments that most of these questions were relatively easy to answer, which he credits to Triodos Bank’s thorough development of the business case and financial model. Some small changes were made on the investors’ request, for instance the inclusion of a representative for the impact investor funds on the CIC’s Board (see Milestone 6).
Biodiversity uplift and reduction in interest rate
A larger piece of work was the development of a biodiversity methodology for the project to use, which took around three months alongside wider investor negotiations. This metric was requested by the Esmée Fairbairn Social Investment Fund at the start of negotiations, as the fund wanted to understand what biodiversity uplift the project could deliver as a ‘co-benefit’ to flood risk reduction, and to incentivize the delivery of this uplift with its investment.
At the time, the Biodiversity Net Gain (BNG) 3.0 metric was under development, and so the project team used this concept and work to date to develop a bespoke but ‘light-touch’ biodiversity metric for the sites being used for the interventions. This work included setting a ‘glide path’ of biodiversity targets for the project to reach over several years. The project team consulted with specialist ecologists and Natural England, which was developing the BNG 3.0 metric, on its findings.
The project team had no intention of selling BNG credits from the project, as the wider market for these was not legislatively supported at the time. Instead, the project team thought that the institutional investors may be willing to reduce the interest rate charged on their debt investment, if the project could prove it had met the biodiversity targets under this methodology.
The metric was then presented back to the Esmee Fairbairn Social Investment Fund, which gave its support for the proposal, before the project team gave a presentation on the methodology and the proposal to the wider group of impact funds. After some negotiations, it was agreed that if the project reached its annual biodiversity improvement target as set out in the institutional loan agreement, the impact funds would reduce the annual interest rate on the outstanding loan balance from 6% to 5% each year. For the sake of prudent planning, this potential financial gain was not included in the finalized financial model – and so this is potential upside for the project.
The project team considered extending this proposal to the loan agreements with the HNW individuals, but after some discussion on the level of due diligence undertaken by the impact funds on the metric, it decided that the HNW individuals would not be able to assess the proposal without sufficient background risk. Therefore this reduction in interest rate was agreed with the impact fund investors only.
Social Investment Tax Relief
An important and unique feature within the Wyre CIC project’s investment model was the offer of Social Investment Tax Relief (SITR) to the HNW investors. SITR was first launched in 2014 and was aimed at helping eligible charities and social enterprises raise both debt and equity investments from private investors for projects or enterprises that create positive social outcomes. SITR is similar in many ways to Enterprise Investment Scheme Relief (EIS) which has been used for many years in the commercial venture capital sector to attract private investment. Like EIS, SITR allows private investors to claim income tax relief on 30% of their investment value. Importantly, SITR (unlike EIS) is available on debt investments as well as equity investments on the grounds that charities do not have share capital.
One of the reasons for selecting a CIC as the special purpose vehicle for the Wyre project at the outset was to structure a debt investment for HNW investors utilizing SITR. A CIC is recognized as a “social enterprise” for the purposes of SITR in a way a private limited company is not. The investment structure, and intention to raise finance from private investors was envisaged at the very start of this project. Hird took the view that this was a way of strengthening the investment offer and decided there was potential in this opportunity due to the increasing trend of impact investment in environmental projects, and the growing public awareness of nature-based solutions
Once the outline business plan and investment structure had been formulated, the project team decided to approach HMRC for advance assurance to offer SITR to its potential HNW investor group.
The SITR application process is challenging because it requires the issuing company to be set up and the application itself needs to include the memorandum and articles, business plan and SITR loan agreement amongst other documents. This meant that in order to make a successful SITR application, the CIC needed to have been formally established and a business plan and SITR loan drafted. Hird says this is quite an investment of time and effort before you know whether HMRC will grant approval for SITR.
Hird further adds that the SITR application process was one of the most difficult elements of the project. Hird submitted the SITR advance clearance application in August 2021 and held a number of conversations, meetings and Q&A with the relevant team at HMRC over the next nine months. HMRC commits to providing a response to most tax clearance applications within 30 days, therefore is indicative of how difficult HMRC found it to come to a decision on the Wyre CIC application.
During this time, negotiations with HNW investors were underway and it was clear that the offer of SITR was a key dependency for HNW investment to be agreed.
Clearance was secured in March 2022. Hird attributes this to the fact that HMRC had no precedent, as the Wyre CIC NFM project was the first nature-based solutions project to seek SITR, and with a unique business model that HMRC had never seen before. HMRC were therefore very conscious that they may be setting a precedent for other nature-based projects and so wanted to test and challenge the model very thoroughly. One of their biggest issues was to challenge whether the CIC was actually “trading” or whether it was simply a construct involving a series of contractual commitments.
Ultimately the project team were able to persuade HMRC to provide assurance. Though securing SITR approval was difficult and drawn-out, the project team hopes that others will seek SITR approval as a way to draw in further investment into nature restoration and preservation.
Formation of the loan facilities
After three months of due diligence and negotiations, the project team and investors agreed to a dual loan facility consisting of two tranches of loans between the impact funds and the HNW individuals. Together, the two tranches offer the full £850,000 over a nine-year period, are both unsecured and offer a 5-6% return over this period.
The first tranche of investment is the ‘Institutional Loan Facility’ that holds £650,000 from the five impact investment funds. The first and largest contribution came from the Esmée Fairbairn Social Investment Fund. This sum will be drawn down gradually over the first three years of the project, and the facility ranks senior to the HNW individuals’ investment, meaning the impact funds will be repaid first in case the project becomes insolvent. The funds also have representation at the Wyre CIC Board. The interest rate is set at 6%, and the impact investors have agreed to an ‘incentive reduction’ in the interest rate of 1% if the interventions deliver certain biodiversity targets.
The second tranche is the ‘SITR Loan Facility’ and holds £200,000 from the four HNW individuals, who each contributed £50,000. The facility ranks junior to the Institutional Loan Facility – functioning more like equity. However, the investors benefit from Social Investment Tax Relief (SITR). The Wyre NFM Project is the first nature-based investment project to qualify for SITR and the Project team hopes that this encourages other nature-based projects to apply and attract private investment.
Upon agreement, the project team did not think it was necessary to use a Memorandum of Understanding (MoU) as with the buyers and sellers, because the investment facility was effectively the last agreement to be obtained in the project’s development. The project team instead proceeded directly to contract negotiation, including the legal set up of these facilities (See Milestone 8).